Know Your Risk Tolerance
Before building a strategy or making investment decisions you need to know your risk tolerance.
Understanding your risk tolerance guides you when choosing investments for your strategy.
You may be wondering “How do I determine my risk tolerance?”
Here is a simple question you can ask yourself to do just that.
“If I had $100,000 and someone offered me a chance to turn my $100,000 into $150,000, but in the process, I would lose 50% of my $100,000 before I make the $150,000, would I take that offer?” For most investors the answer is “no,” but the ones who answer “yes” have a very high-risk tolerance.
If you answered no, ask yourself the same question again but instead of potentially making $50,000 you could make $20,000 and only lose between 15%-20% along the way. If this is more appealing to you, you could classify yourself as having moderate risk tolerance.
Lastly, if the first two scenarios do not appeal to you, you are most likely a low-risk investor. Meaning, you do not like the thought of risking capital and want more moderate returns that over time compound into much larger gains. This is what most investors want and strive to achieve.
Have a Basic Understanding of the History of the Market
As the saying goes, history repeats itself, and that has held true, especially for the stock market.
In the short term, the market traditionally follows a pattern, starting with a trend either up or down, followed by a sideways pattern, then a continued trend in the same direction.
In the long term, the market will periodically trend very far in one direction, then trend sideways only to reverse, and then trend in the opposite direction.
With a basic understanding of how the market has reacted in the past, you can identify current trends and make an educated guess on what may occur in the future.
It is important to note that your predictions will not be short-term, but long term spanning 2 to 10 years. That said, let’s take a look at what the market has done throughout its history.
1900-1960 Dow Jones Industrial Average
The 1900s had a rocky start. A strong bull market in the 1890s led to a correction in 1903 and a stock market crash in 1907. The correction was followed by a period of consolidation. After the consolidation period, the market came into a period known as the Roaring 20s, until 1929 when the Great Depression hit and the Dow Jones fell from around $400 to below $50.
The market entered a period of consolidation and did not fully recover until 25 years later.
1961-2009 Dow Jones Industrial Average
The 1960s rallied off the bull market of the late 50s, but in 1965 the great inflationary period began bringing the market into a long period of consolidation. From 1983 to 1987 the market began a sustained uptrend ending the inflationary period.
The 1990s were a period of great economic expansion led by the tech market. This lasted, with a few bumps in the road, until 2000 when the market rolled over experiencing little to no growth capped off by the Dot Com crash.
The market recovered, but crisis struck again, this time it was the Great Recession of 2007 and 2008.
2010-Present Dow Jones Industrial Average
From 2010-2021 the market rallied but had numerous corrections within the rally including, the COVID correction.
In 2022 the market entered into a correction phase and trended lower for the first six months of the year and is now in a period of consolidation.
The market does not continuously go up. It has huge corrections and long periods of consolidation along the way. Those are the periods you need to be prepared for and know how to handle them. By having a good understanding of the history of the stock market you may be able to successfully navigate these periods without too much harm.
Make Your System Mechanical
A mechanical system takes the emotion out of investing. Buying and selling based on your gut feeling is not the best way to do it, and in most cases does not produce good results. A good way to take the emotion out of investing is to have indicators that tell you the market's general direction at a given time. There are many types of indicators, but a good one to use is a moving average. A moving average tells you where the investment is currently trending and you can use this information to predict how it may trend in the future.
Invest in Uncorrelated Asset Types
What is an uncorrelated asset? Uncorrelated assets are a group of assets that do not have any relational pattern between them.
How do you invest in uncorrelated assets? A good way to invest in uncorrelated assets is to invest in many different sectors of the market. Examples of different sectors are gold, treasuries, Nasdaq 100, S&P 500, etc. You need to backtest the group you selected to make sure that your portfolio is not closely correlated to the market.
Know Your Portfolio’s Risk-to-Return Ratio
Know your risk-to-return ratio! Too many people invest their capital without genuinely understanding the risks associated with their investments.
The underlying ideology that the stock market will continue to go up forever with only little corrections or periods of lag is not valid.
Before a person begins investing, they must determine how much risk they are willing to take to achieve their desired return. In addition, investors must understand that investing in the stock market is not a sure bet. While it can provide significant gains, it can also cause substantial losses.
The stock market can be tricky, so investors must optimize their risk-to-return ratio by back-testing their portfolios and implementing strategies that indicate when to be in and out of the markets.
By using a back-tested portfolio, a person can confidently choose and understand the risks associated with their investments.
Get a Second Opinion
A second opinion on the strategy you develop is critical! Most people are biased about the strategies they create, but by consulting someone to review your strategy you can remove that bias, but who do you talk to?
Your investment advisor would be a good person to discuss your strategy with. if you do not have one you can contact us either through our Contact page on our website or by sending an email to rustyvernon@vernonmanagement.com.
Conclusion
In conclusion, the stock market is complicated and can either be a great investment or a mediocre one depending on how you go about investing. However, by following these six tips you will be one step closer to success.
To learn about Vernon Management Group's Investing Strategy click here.
If you have any questions please contact Vernon Management Group at rustyvernon@vernonmanagement.com.
This is not tax advice. Please consult your tax advisor before making any tax decisions
*Please consult your tax advisor before you make decisions that involve tax laws
This is not a recommendation to buy or sell securities
Past performance does not guarantee future return
In most cases our Market Data Sources are
Schwab Data Files
Portfolio Center
Yahoo Finance
MarketSmith
MarketWatch
and other trusted websites.
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